We think Chinese President Hu Jintao has it about right on the dollar.
The current international currency system is the product of the past, Hu told the WSJ ... noting the primacy of the U.S. dollar as a reserve currency and its use in international trade and investment. He went on to say that loose monetary policy from the US floods the world with liquidity and the liquidity of the US dollar should be kept at a reasonable and stable level. Mr. Hu is right here too. It is monetary madness. But Mr. Hu need only look in the mirror if he wants to see the other culprit in this game.
There is no doubt the US has abused its world reserve currency status for some time. But when the world requires dollar liquidity, as it did during the credit crunch, it was the Fed who steps into the breach. It shows the double-edged sword reserve status bestows on a country. Damned if you do and damned if you don't. If US monetary policy got too tight (yes, hard to imagine) we suspect countries would be complaining about that too.
But, that said, it does not excuse the US for pretending that monetary policy can be substituted for real economic policy. It doesn't excuse the US for abusing the US world reserve currency status, assuming it will always be as it is and countries must hold dollars to settle international trade of real goods.
Mr. Triffin, he the founding partner of Triffin's Dilemma, foresaw all this monetary madness back in 1959 as the US dollar began to become the center of the global monetary system in place of gold.
The first major bout of severe inflation to truly threaten the US system began to rage shortly after the link between paper money and gold was severed in 1971 by President Nixon. But the primary cause wasn't the severing itself, but the monetary madness and constant devaluations relative to the dollar by those wanting major trade advantage which incidentally came at a time when some would say we had global cooperation on monetary matters. There was also a big overhang of dollars on the world market and there was a belief the US could easily fund a war in Vietnam and the new Great Society
that would vanquish all ills. Money in place of discipline is a consistent hallmark of the political hack mindset throughout history; I might editorialize for you who hate it so.
This leads to a question for Mr. Hu? What precisely would you want the global monetary system to look like in the end, other than of course RMB replacing the dollar as global reserve currency (a system you say doesn't work now that Mr. Greenie is at the center)?
Be careful what you wish for Mr. Hu, as most of the competing monetary regime ideas on the table all have little nugget at their center-penalties for imbalance, i.e. countries like yours that manipulate their currency in order to create mercantile advantage would be punished. Would that be to your liking Mr. Hu? Really?
Of course people who didn't experience the ebb and flow of unemployment and crises and labor taking the brunt of the adjustment during the era of the gold standard hearken back in a belief it was an angelic time of life, when the birds sung more sweetly and global love and cooperation flowed (forgetting it proceeded WW1 -- poisonous gas and all other assorted horrors of modern weaponry on display). Well, the gold standard era was a magical era to a large degree. But it required that monetary stability be the only mandate for a central bank. During that period labor had very little power-capital (oh yes, that evil capital) was king. The average worker bore the brunt of the ebb and flow of adjustments required to keep the exchange rate stable. This is why there was deflation during most of the gold standard era. It was the good kind of deflation, one would say, where real productivity and incomes rose. [Note: This is not to downplay the abuse of many average workers during this period. That was real. And that abuse spawned the real need for union power to provide some balance. My grandfather, a hard-working blue-collar man of class and integrity was a staunch union man because of his experience during this time. But, unions went too far I believe. Their power corrupted. Nothing new...life seems a continual struggle for that balance of excesses human nature can't seem to shake.]
Deflation during the gold standard effectively allowed the market to clear. It played its primary role of cleansing the system of dead wood, setting the stage for fresh growth. Thus, the panics during the gold standard ultimately proved healthy for the global economy. The boom in global trade and investment and productivity was staggering, relative to any point in history before then.
Do you think this type of system-the gold standard-has a snowball's chance in hell of reappearing if it requires labor to take the brunt of adjustment? How in the heck would the politicos cope with the idea of not helping their cronies and us on a consistent basis? After all, full employment is a right for all people, don't you know. And the politician's perceived ability to help us remain employed is the key source of their power.
So, Mr. Hu, we ask again: what does the system look like that you so naively say needs to change? A system that has served China pretty darn well, an objective observer might surmise. (see China GDP chart below).
China needs global capital flow, i.e. cross border flow of capital and investment in order to support its ongoing development. It doesn't yet have the depth of capital market to fund all its needs on its own. Therefore, a pegged system of exchange rates, whereby capital flow is strictly controlled, wouldn't serve the Chinese well. Nor would that type of system serve a global economy well that is now more dependent on cross-border capital flow than it ever was. And remember, at its core, a pegged system (globally) requires a high degree of cooperation among its members. If anyone paid attention to the G-20 during their last photo session in Seoul, South Korea, you know cooperation among the powers that be is in tatters.
So, let's now tick them off:
Gold Standard - Would be great for monetary stability and real growth based on real value. It would be great for controlling our political hacks of all stripes from wasting our money ... but labor unions and their hack supporters and cadre of incompetent suck-ups latched to the government teat, and assorted alliances in the media, would surely pass a verdict of mean and uncompassionate on a monetary system that required real discipline and creation of real value instead of income distribution to a bunch of moochers. Until there is a major cultural shift here and abroad, this dog won't hunt. Unfortunately!
Pegged Standard-A pegged standard, outside the US dollar, to something like IMF Special Drawing Rights (SDDRs) is technically viable. But, we think it would put a major damper on cross border capital flow and require a degree of surveillance and cooperation far and away beyond anything the major powers would be willing to accept.
Keep in mind, if these monetary regimes were easy, Europe would not be in the midst of a crisis right now. There are many unintended consequences that flow from trying to create standards at a point in time that will prove effective long-term as the global market place and finance and needs evolve.
So, we now have the fiat money standard with the US at the center. We are stuck in Triffin's Dilemma.
We all hate it and despise it and think we can make the global monetary system better. We can. But much is required to do so. And we tend to forget, for all its warts, the US dollar as reserve currency has served global growth pretty darn well when considering the hundreds of millions of people who have been lifted from poverty world wide as the world grew since the 1970s and globalization blossomed.
Now of course the rising concern is the fiat system is about to saddle us with yet another runaway global inflation problem (now that the system is globalized, we argue there are many more culprits here than just the US Fed; lest we forget how hard China has pumped money into its economy to replace the demand lost since the credit crunch.)
The British pound jumped today on a growing belief the Bank of England will be forced to raise rates in June thanks to rising price pressures in Britain (a warning this may morph into the industrialized world from the emerging markets). Emerging markets are in the midst of deciding whether they risk growth or inflation, as they ponder necessary interest rate increases. And who is at the center of this problem (debate) once again: Good old Mr. Greenie!
Thanks to the world's de facto central bank-our illustrious Federal Reserve--throwing all that liquidity into the market, as Mr. Hu so rightly points out, pretending money can replace discipline (we always want the easy way out), global liquidity has hiked up tremendously. But guess what ladies and gentlemen, others have played a contributing role here.
If emerging markets let their currencies absorb the big burst of liquidity by appreciating accordingly, they would not have the inflation problem they now have. Instead, they want it both ways: They want capital flow to grow, but require it on their own terms. They want to export. Thus, they believe they can suppress their currencies and not have an inflation problem? Blame US is the easy solution. In a world of floating exchange rates, the currency IS the relief valve.
And guess what, if countries accepted the current market system, and allowed their currencies to take the brunt of capital inflow, denting dangerous inflation, these same countries would have a stronger incentive to foster more and faster development of domestic markets (which of course leads to more political freedom and consumer choice Mr. Hu). This in turn would naturally lead to better relative balance on global trade, reducing friction among the various trading partners that now threatens the global trading system.
So yes, the Fed has been too loose. It has been irresponsible. But if others allowed the market to work under the current global monetary system with the US dollar as the world reserve currency, things would be much better off in the long run.
Mr. Hu can talk till the cows come home about how important it is to have a better monetary system...blah...blah..blah...but until China steps up to prove they are a responsible party in this game, why listen?
Let's compare China's GDP growth to its currency, as you can see in the charts below. A few points:
1) China's currency is still weaker than it was in 1992.
2) China's currency has appreciated 26.7% since it started appreciating back in 2004; yet its GDP has grown a whopping 120%, roughly, during that same period.
3) And when you consider the US dollar is down significantly since 2004, imagine the mercantilist impact China's currency policy has had on others-it has been much worse for them than it has been for the US. Hmmmm...
(See USD-CNY and China GDP chart below)
Let the smile diplomacy begin!
Black Swan Capital